Court of Appeal confirms that the 'Edwards' decision applies to time bar and that once a company is restored to the register, actions taken during the period of its removal are retrospectively validated
2017 case note - CIR obliged to form opinion on the face of a tax return that it is fraudulent or willfully misleading - time bar, removal from Companies register.
This case was an appeal from the High Court decision of Great North Motor Company Ltd (in rec) v Commissioner of Inland Revenue  NZHC 2708. In that case, Downs J found that the transaction underlying tax losses accumulated by Great North Motor Company Limited (in rec) (“Great North”) was a tax avoidance scheme.
Great North did not appeal the finding of tax avoidance, rather it focussed on its position that six of the 12 assessments amended were time barred by s108(1) of the Tax Administration Act 1994 (“TAA”). Downs J had found that even if the time bar had expired, the tax returns filed were fraudulent or wilfully misleading, and thus it did not apply. Alternatively, he found that the time bar did not apply because time did not accrue during the period Great North was struck off the register.
This decision confirms the time bar approach taken in Legarth v Commissioner of Inland Revenue  NZLR 312 (“Legarth”) and Edwards v Commissioner of Inland Revenue  NZHC 1795, (2016) (“Edwards”). The Commissioner of Inland Revenue (“the Commissioner”) is obliged to form an opinion on the face of a tax return that it is fraudulent or wilfully misleading. In a challenge proceeding, the hearing authority stands in the Commissioner’s shoes in all respects when considering a challenge in relation to the opinion formed under s 108(2) of the TAA and forms its own opinion on whether the returns filed were fraudulent or wilfully misleading as if it is the Commissioner. However, the taxpayer bears the burden of proving that the returns were not fraudulent or wilfully misleading.
This decision also confirms the test for determining whether a return was ‘wilfully misleading’ as settled by Turner J in Babington v Commissioner of Inland Revenue (no 2)  NZLR 152 at -.
Finally, the Court found that once a company is restored to the register, s 330(2) of the Companies Act 1993 applies and neither the restored company nor third parties can challenge the validity of actions taken during the period of its removal. Accordingly, the Commissioner needs to monitor the register (or gazette) and notices of pending restoration of companies with a view to objecting to restorations where appropriate.
Great North filed income tax returns claiming deductions for losses of about $21.7 million suffered from business activities between 1996-2001 (inclusive). The Commissioner originally allowed the claim but later disallowed it and assessed Great North on the basis that the arrangement was a tax avoidance arrangement. The Commissioner also imposed shortfall penalties for taking an abusive tax position. Great North challenged the Commissioner’s assessments.
The High Court found that the Commissioner was correct to conclude the arrangement was a tax avoidance arrangement and to impose an abusive tax position shortfall penalty. The High Court also held that the returns filed were misleading for the purposes of s 108(2) of the TAA on the basis that Mr Russell had actual knowledge that the arrangement constituted tax avoidance (or that it was highly likely tax avoidance (subjectively reckless)). Lastly, the High Court concluded that the s 108 time bar commenced only when Great North was restored to the register on 8 October 2010. Only then did the Commissioner have a “taxpayer” with whom to deal.
Great North sought to appeal certain aspects of the High Court decision but did not appeal the tax avoidance finding.
Standard of appellate review
In determining Great North’s appeal, the Court of Appeal considered that it must resolve a threshold question about the appropriate standard of appellate review of the Commissioner’s opinion.
Counsel for Great North submitted that the correct approach for the hearing authority, in this case the High Court, when determining a challenge to the Commissioner’s assessments under s 138P of the TAA is to stand in the Commissioner’s shoes and consider afresh whether the return in question is fraudulent or wilfully misleading. Accordingly, the hearing authority must substitute its own view for the Commissioner’s view if she has erred. Counsel for Great North accepted that Great North carries the burden of proving it did not submit a wilfully misleading return. The Court of Appeal considered that this correctly stated the ratio of the Court of Appeal’s decision in Legarth.
However, the Court’s attention was drawn to a later decision of the Court of Appeal, namely Wire Supplies Ltd v Commissioner of Inland Revenue  NZCA 244,  3 NZLR 458 (“Wire Supplies”) which might stand as authority for a lower threshold of appellate scrutiny, limited to simply one of review of the evidential foundation or reasonableness of the Commissioner’s opinion.
The Court noted that at first blush, Wire Supplies might seem contrary to Legarth, which was not apparently cited in argument. However, the Court of Appeal was satisfied that in Wire Supplies the Court of Appeal was answering a limited submission for the taxpayer, addressed solely to the evidential adequacy of the Commissioner’s opinion. The Court of Appeal considered the apparent differences in the approaches adopted by the Court in those two cases are reconcilable when the circumstances of Legarth were examined more closely.
The Court of Appeal referred to the decision of Edwards, in which Williams J reviewed a number of High Court decisions addressing a same or similar issue. The Court of Appeal agreed with Williams J’s conclusion following Legarth, that the hearing authority’s reconsideration of the Commissioner’s time-bar ruling is not restricted to whether her opinion under s 108(2) of the TAA was honestly held and reasonably available on the evidence. The hearing authority is obliged to review de novo.
The Court considered the approach adopted in Legarth to be consistent with the purpose of s 108(2) of the TAA. The Court considered that approach reflects the Commissioner’s obligation to form an opinion on the face of a tax return that is fraudulent or wilfully misleading. She has neither the time nor the resources to conduct a full evidential enquiry. In the event that the taxpayer challenges an amendment made more than four years after the Commissioner’s assessment, the hearing authority must be able to substitute its own view for the Commissioner’s opinion of the correct liability to tax having considered the application of the relevant legislation and relevant evidence. The Court of Appeal confirmed that the taxpayer bears the burden of proving to the civil standard that its returns were not fraudulent or misleading which the Court considered is an exacting requirement where the Commissioner has made compelling findings that the underlying affairs were designed to avoid tax.
Test for “fraudulent or wilfully misleading”
The Court of Appeal confirmed that the correct test to be applied in determining whether a return was “wilfully misleading” is found in Babington v Commissioner of Inland Revenue (No 2). Proof of mere negligence or breach of duty is not enough. There has to be knowledge that the return is materially inaccurate coupled with an intention to mislead. Subjective recklessness is sufficient where it is demonstrated that the person submitting the returns had no reasonable ground for believing that the returns were correct, where the only inference reasonably available is that he or she must have adverted to the probability or possibility that the returns were false, and was reckless in the sense of not caring whether they were correct or not.
The Court of Appeal considered that the Commissioner’s claim that Great North’s tax returns were fraudulent or wilfully misleading required proof of two sequential elements. Firstly, whether a particular return is misleading; would the returns on their face mislead the Commissioner?
Having approached the matter afresh, the court was independently satisfied that all returns filed by Mr Russell for the relevant years were wilfully misleading within the meaning of s 108(2) of the TAA. The Court also came to the conclusion that Great North had fallen well short of discharging its onus that the returns were not wilfully misleading and to the contrary were satisfied that Mr Russell at the very least acted recklessly and with wilful disregard that the Commissioner would disallow the company’s losses as being claimed under a tax avoidance scheme.
Accordingly, the Court concluded that the Commissioner’s amendments were not time barred under s 108(1) of the TAA.
Section 330 of the Companies Act 1993
The Court of Appeal disagreed with the High Court’s decision that retrospective validation of Great North’s existence, deemed (under s 330(2) of the Companies Act 1993) by its 2010 restoration to the register, did not have the effect of validating the company’s returns to the time of filing in 2005, 2006 and 2007.
The Court of Appeal stated s 330(2) is straightforward and fair: neither the restored company nor third parties can challenge the validity of actions taken during the period of its removal. The Court considered that ss 328(6) and 329(4) exist to protect creditors who understood they were dealing with a registered company during the period of removal and who would otherwise have no right to pursue the restored company on those transactions by enabling them to apply to the Court to wind back the clock.
The Court agreed with Counsel for Great North that the purpose of s 330 is strictly restorative and unequivocally deems that the company has “continued in existence as if it had not been removed from the register”. Therefore, the legal effect is that the returns were filed on the day they were filed as if the company was then in existence.
The Court considered that the Commissioner would have arguably been entitled to apply for judicial review of the Registrar’s decision to reinstate Great North from 10 October 2010 on the ground that Mr Russell’s purported appointment as receiver on 26 May 2005 was invalid.
In response to the Commissioner’s submission that she has neither the time nor the resource to restore companies to the register in order to comply with her statutory responsibilities, the Court stated that they would have assumed the Commissioner was monitoring closely the corporate machinations of Great North and its associates. In any event, the Court found that s 108(2) of the TAA is an effective safeguard for the Commissioner and the maintenance of the tax base. A company which was not carrying on business – neither when it was removed nor throughout the period it was struck off – had no lawful reason for filing tax returns other than to obtain a benefit to which it was not entitled.
The Court stated that had they not found that Great North’s returns were fraudulent or knowingly misleading, the four-year time bar provided by s 108(1)(a) of the TAA would apply to six of the Commissioner’s assessments.
The appeal was dismissed and costs awarded to the Commissioner.
Tax Administration Act 1994 s 108 (1) Companies Act 1993 s 330